The Most Important Sentence in Netflix's Earnings Report

Netflix streams another solid quarter.

U.S. stocks finished marginally lower on Monday, as a big week for company earnings got under way. The S&P 500 fell 0.2%, while the narrower Dow Jones Industrial Average (DJINDICES:^DJI) lost 0.3%. The technology-heavy Nasdaq Composite Index (NASDAQINDEX:^IXIC) was down 0.2%.

Shares of Nasdaq component Netflix(NASDAQ:NFLX) outperformed the index with a 1.8% return in the run-up to the company's second-quarter results, which were announced after the market close. That "pop" appears to have well anticipated the results, as the stock is not reacting much in the after-hours session.

First, the numbers. The following table summarizes Netflix's performance on revenues and earnings per share, both on an absolute basis and relative to Wall Street's expectations:

Metric

Actual/Year-on-Year Growth

Consensus Estimate

Revenues

$1.34 billion

+25%

$1.33 billion

Earnings per share

$1.15

+135%

$1.16 billion

Sources: Netflix, Thomson Financial Network.

The report looks very respectable all around, but one paragraph in particular, caught my eye (my emphasis):

In May, we raised prices modestly in most of our markets for new members on our two screens at-a-time HD plan. ... We expect ARPU to rise slowly as members at the new prices grow as a percentage of total membership. There was minimal impact on membership growth from this price change.

This is critical information, because a company's ability to raise prices -- its pricing power -- is an indicator of the width of its competitive moat and a potential turbocharger for long-term earnings power (and, by extension, share returns). Superior businesses often benefit from substantial pricing power.

To be clear, the May price rise gave no indication of Netflix's ability to raise prices on existing customers per se, as they will continue to pay the "old" prices under a two-year grandfather clause. However, it was a test of Netflix's ability to continue attracting new customers at higher prices -- one the streaming video and television company appears to have passed with flying colors: Domestically, Netflix added 570,000 streaming customers, with 1.1 million additions internationally; both figures are ahead of the forecasts for 520,000 and 940,000, respectively, that the company provided in April. With 36.2 million users, Netflix is now the largest standalone subscription programming service in the United States.

Incidentally, Netflix's price rise was not that "modest" -- a $1 increase relative to $7.99 equates to a 12.5% rise. In 2013, broker RBC Capital Markets polled 1,025 Netflix customers in the United States. Less than a fifth (17%) of respondents said they would be "extremely likely" or "very likely" to cancel Netflix following a hypothetical $1 price increase, compared with 30% who said they would be "not at all likely." I think that actually overstates the likelihood of customer defections. Personally, I'm in the "not at all likely."